Vehicle-Financing Costs

Vehicle-financing costs are the costs you incur when you buy an auto. If you buy an auto with cash, you don't pay any direct financing costs. However, the money that you take out of savings or an investment to pay for the auto has an opportunity cost.

For example, if you take $20,000 out of an investment account that earns an average of 8% a year, the opportunity cost is almost $9,400 over five years. That's the interest your money would have otherwise earned had you left it alone. Opportunity cost is even greater if you raid a tax-deferred account.

If you buy an auto, the major financing cost will be the interest expense and loan fees that you pay for the loan. (With a surge of zero-percent loan financing in the past few years, qualified consumers were able to obtain interest-free auto loans.) You also pay upfront costs to the lender when you close a loan. Keep in mind that sales tax, registration and other fees are added to the auto purchase price, boosting your financing costs.

If you lease an auto, the main difference from borrowing is that you don't own the auto at the end of the lease term. (Depending on the type of lease, you may have an option to purchase the vehicle or may be able to renew the lease term.) Industry terms used in auto leasing are different but often match up to those used in auto lending.

The capitalized cost reduction is synonymous with a down payment on an auto. You will have to pay a security deposit, which is often refunded at the end of the lease term unless you violate the lease agreement. You'll also have to pay taxes and registration fees for a lease. Leases require you to make the first monthly payment upfront.

Generally, the average yearly cost of owning a vehicle decreases after a couple of years of ownership, making it more economical than leasing if you keep the auto for more than a few years. Moreover, the auto becomes yours as you pay off the loan. With a lease, you have to fork out a substantial sum at the end of the lease term to purchase the auto at its residual value.

Some circumstances may favor leasing. Often, leasing is preferred by people who like to drive a new car every few years, prefer not to own a car or can deduct lease payments as a business expense. You should be sure to thoroughly understand the terms and conditions of a lease agreement to ensure refund of your security deposit.